April 12, 2009

Close.... But we need $ 500K per ton hour of Capacity

The drop in the price of coal has gotten the attention of everyone following Torrefaction .

From an investment viewpoint, part of the challenge with Torrefaction is the sheer number of variables involved; price of feedstock, price-to-compare for delivered coal, impact of Carbon Credits, and what the cost of processing equipment will be.

When you stack probabilities on top of probabilities, the percentages are not your friend.

When coal prices were above $ 120 a short ton, Torrefacton made economic sense without Carbon Credits with plenty of headroom for increases in feedstock prices, and a wide range of prices for equipment and operating costs.

Now that coal is way down we've rerun a lot of numbers (I'll share you the geeky probability trees) but the result is pretty clear.

We Need the Price of Torrefaction Equipment to be $ 500,000 per ton hour of capacity for Torrefactoin to develop pre Carbon Credits. This is the price at which an investor can reasonably take the gamble on the ups and downs of coal prices and the other variables.

Unfortunately, this is about twice the low end of the range of prices we're getting. When we have greater clarity on Carbon Credits, the industry may be able to afford higher equipment prices. Carbon Credit clarity is the case in Europe right now and Torrefaction makes great economic sense for biomass serving that market. So maybe Torrefaction will develop for the export market first (just as Green Circle is exporting the pelletized woody biomass from Florida.

However reaching the magic number of $ 500K per ton hour of capacity is quite achievable and a much closer putt than .50 cents (installed) per watt of solar energy, or $ 500 per kw (installed) for Wind. Not that these are bad technologies -- they're not and we support all renewables in a multi-technology strategy to get us to 20% renewable; but here's the point:

Biomass, and Torrefaction in particular are a shorter putt. Reaching $ 500 per Ton Hour of Capacity is just not that far off, and the industry develops at that price because that price can support all the variabilities in other inputs.

$400k hould be possible for 2nd generation torrefaction reactors. However, far more important is the cash costs of the reactor system; electricity consumption and maintenance. Every $100k you lower the reactor price per ton produced relates to a cost price reduction of $1 per mt(@8% cost of capital). So $600k versus $300k does not make or break it but cash cost do!

Unfortunately, I think this is one of those answers that "depends". Electricity costs are all local -- $ .08/kwh in Southeastern USA, $ .28/kwh in parts of Europe.

I think we could agree that it also depends on the time horizon on financing. At 8.5%, 5 years financing, and 8,000 hours of operation a year, the difference between $ 500,000 per ton hour of capacity and $ 1,000,000 per ton hour of capacity is $ 15.00 per ton of output.

My own analysis indicates that the economics of torrefaction are most sensitive to:

2) capital cost if loan period is less than say 7 years (and long money is hard to find these days)

3) Operations and maintenance

The problem with long term financing is that someone is making a longer term bet on the commodity spread -- and that's the real key to the economics.

Right now commodity spreads are good in a few parts of the world, and 'ok' elsewhere. I think everyone expects the price of hydrocarbons to rise over the long period, but the long term price expectations for biomass are less clear. A lot depends on Cap&Trade and subsidies. Biomass prices could rise quickly eliminating the spread. That's why I believe that these projects will have to stand on shorter term financing horizons, and that the installed cost per ton hour of production is the key. Get that low enough, and investors will be able to make numbers work with shorter term financing, or will finance for longer terms but plan that the plant may be idle for a few years is commodity spreads disappear (which they very much might).

The ethanol industry provided a harsh example of what happens to feedstock prices when the industry develops. But I don't want to make too many comparisons to ethanol -- it was just dumb. Torrefaction is smart.

Is there an opportunity for some financial engineering(a dirty word these days, I know), to address some of the issues you raise above?

IE: Divide and conquer each bucket of risk (feedstock, coal, and carbon credits) through the futures / derivatives markets. Package it all together and give it a catchy name like "CLOBS" (Coal Less Offsets - Biomass Spread). Will never address the turely long term systemic risk, but at least could provide the prospect of stable economics for a 12 to 18 month period.

Potential?

Obviously some major obstacles, and a critical mass the market potential needs to reach for high finance to get truely involved (especially on the carbon credit side)...but I feel like that is inevitable.